The recent New South Wales Court of Appeal decision in Fast Fix Loans Pty Ltd v Samardic [2011] NSWCA 260 (Fast Fix) suggests that if a lender relies solely on the security provided by a guarantor and does not assess the borrower’s capacity to repay then the guarantee may be unenforceable.

Further, measures that would otherwise appear prudent, including ensuring that the guarantor had obtained independent legal advice in their native language in relation to the implications of the transaction, may not be sufficient to guard against a finding that the guarantor did not understand the transaction and the guarantee should be set aside.

Although this decision was made under the Contracts Review Act 1980 (NSW), the principles applied by the Court could apply equally to any guarantee that is capable of being challenged on the basis that it is unfair or unjust and even if there is no statutory obligation to assess the borrower’s capacity to repay.

Background facts

The borrower was the sole director of a company and he obtained bridging finance from Fast Fix Loans Pty Ltd which he made available to the company. There was no statutory obligation to assess the borrower’s capacity to repay. 

The bridging finance was secured by a guarantee from the borrower’s parents who also provided a mortgage over a residential property.

The parent guarantors were retiree immigrants and although they obtained legal advice in relation to the transaction the Court found that they  “had no understanding of the transaction and the significant risk that they were undertaking because of the financial position of the company”.

Decision of the Court of Appeal

The Court considered whether the guarantee was unjust under the Contracts Review Act 1980 (NSW). 

Although this legislation has previously been relied on to find a loan contract unjust where a lender has engaged in “asset lending” practices in relation to the borrower (that is relying solely on the security provided by a borrower instead of assessing their capacity to repay the loan) in Fast Fix the court extended these principles to the guarantee.

The Court found that the lender was relying on either the loan being refinanced by the borrower or the lender enforcing the mortgage provided by the guarantors.  The Court found that the lender was “indifferent to their [the borrower’s] ability to make payments under the loan because of the security they [the guarantors] were providing”. On this basis the court found that the parents had entered into an unjust transaction, which was therefore set aside.

Allsop P, at paragraph 43, stated:

There is no reason why considerations such as those here cannot lead to the conclusion that a contract of guarantee is unjust if entered into by a lender who is uncaring of a guarantor's capacity to repay where there is a real and significant possibility of default by the borrower and the guarantor takes no benefit under the borrowing.  This is particularly so in all the other circumstances of this case - most particularly the recognition by the appellant of the only two likely sources of repayment, one (successful refinancing) having a real risk to it.  The appellant lent at a significant interest rate, reflecting the underlying commercial risk, appreciating the position the parents had been placed in, without any basis to consider that the parents appreciated the commercial risk or that they could afford to take that risk.

Fast Fix Loans Pty Ltd sought to argue that it was an innocent party and should not be punished as it had not appreciated the unjust elements of the transaction.  This argument was rejected with the court noting that “moral obloquy” was not required in finding the existence of an unjust contract.  The court found that the lender’s lack of knowledge was a product of its own failure to enquire and could not be relied on for its benefit.